{"id":35933,"date":"2026-11-13T12:06:38","date_gmt":"2026-11-13T17:06:38","guid":{"rendered":"https:\/\/www.rbcwealthmanagement.com\/en-ca\/?p=35933"},"modified":"2026-11-13T12:06:40","modified_gmt":"2026-11-13T17:06:40","slug":"the-space-between-federal-reserve-theory-and-practice","status":"publish","type":"post","link":"https:\/\/www.rbcwealthmanagement.com\/en-ca\/insights\/the-space-between-federal-reserve-theory-and-practice","title":{"rendered":"The space between Federal Reserve theory and practice"},"content":{"rendered":"\n<p class=\"wp-block-paragraph\"><strong>By<\/strong> <strong>Atul Bhatia, CFA<\/strong><\/p>\n\n\n\n<p>\n      The latest market-moving jolt was the October consumer price index report\n      showing prices increasing well above the Fed\u2019s target, with a pair of\n      central bank speakers indicating that the numbers could justify a more\n      forceful policy response.\n    <\/p>\n    <p>\n      While we don\u2019t doubt the sincerity of those comments, we think it\u2019s still\n      an open question of how the Fed will respond in practice, with the\n      inevitable tradeoffs and risks of major policy initiatives.\n    <\/p>\n    <!-- SECTION -->\n    <h2>\u201cShould do\u201d is easy<\/h2>\n    <p>\n      The \u201cright\u201d decision for the U.S. central bank in December is, we believe,\n      pretty easy: hike overnight borrowing rates and issue a strong statement\n      in support of further tightening to tame inflation. The strength of the\n      statement may be difficult to achieve without dipping into the \u201cforward\n      guidance\u201d that Fed Chair Kevin Warsh opposes, but it should be possible to\n      communicate resolve without commitment. Something along the lines of Mario\n      Draghi\u2019s famous \u201cwhatever it takes\u201d comment in support of the euro during\n      his time as head of the European Central Bank could serve.\n    <\/p>\n    <p>\n      That outcome is, we would argue, the only one that is consistent with the\n      Fed\u2019s mandate and economic data. The U.S. central bank is supposed to seek\n      full employment consistent with price stability. The latest jobs report\n      showed the labour force growing and the unemployment rate shrinking,\n      indicating that the U.S. is creating jobs faster than it is workers.\n    <\/p>\n    <p>\n      At the same time, inflation continues to be above the Fed\u2019s target, with\n      core consumer prices rising 0.3 percent between September and October.\n      This core measure strips out energy and food prices, which tend to be more\n      vulnerable to supply shocks and less predictive of future price moves.\n    <\/p>\n    <p>\n      With prices a problem and employment fine, it seems clear to us that the\n      Fed should address prices using the main tool in its toolkit\u2014higher\n      overnight interest rates. Since the Fed has been missing its inflation\n      target for five years, we think it is entirely appropriate to go for a 50\n      basis points (bps) hike, reinforced with as strong a verbal message as\n      Warsh can give. Alternatively, the central bank could choose to do 25 bps\n      in December and another 25 in January\u2014the difference is largely noise.\n    <\/p>\n    <p>\n      What matters, though, is that the Fed takes advantage of strong labour\n      markets to be more aggressive on prices.\n    <\/p>\n    <!-- SECTION -->\n    <h2>\u201cWill do\u201d is less clear<\/h2>\n    <p>\n      That, at least, is the theoretically sound answer. Whether Warsh and Co.\n      will follow through on that is more challenging.\n    <\/p>\n    <p>We see three reasons why the Fed may end up disappointing the hawks:<\/p>\n    <ol class=\"list-spaced\">\n      <li>\n        <strong>Equity markets like cheap money.<\/strong> As recent market\n        action has reinforced, higher Fed policy rates are challenging for\n        stocks. With upper-income household consumption accounting for about a\n        third of U.S. economic activity, the Fed has to consider the impact on\n        wealth effect spending of higher rates.\n      <\/li>\n      <li>\n        <strong>The U.S. government needs cheap money.<\/strong> At the end of\n        the day, the Fed is an agency of the U.S. government. With the U.S. debt\n        at 100 percent of GDP and lawmakers failing to tax in line with their\n        spending, budget sustainability requires interest rates that are below\n        nominal GDP growth. Rising rates put pressure on the budget.\n      <\/li>\n      <li>\n        <strong>Everyone loves a cheap dollar.<\/strong> Unjustifiably low\n        interest rates will tend to weaken the dollar versus other currencies.\n        That weaker dollar can help support other asset prices, such as stocks\n        and home values. Overseas investors can use their stronger currency to\n        buy up U.S. assets. The net result is that for investors with\n        significant investment portfolios, the weaker currency can potentially\n        give apparent gains.\n      <\/li>\n    <\/ol>\n    <!-- SECTION -->\n    <h2>Consequential decision<\/h2>\n    <p>\n      While no one Fed meeting is particularly consequential\u2014monetary policy\n      develops over time\u2014the overarching policy path is. And for investors, a\n      Fed dedicated to the strict bounds of its mandate and laser-focused on\n      inflation has significant investment implications:\n    <\/p>\n    <ul class=\"list-spaced\">\n      <li>\n        <strong>Economic growth faces headwinds.<\/strong> Consumers face a\n        greater opportunity cost with their spending, and households with credit\n        card debt will feel the pinch.\n      <\/li>\n      <li>\n        <strong>Stock markets could struggle.<\/strong> Slower growth and higher\n        rates create a difficult environment for equity investors, particularly\n        those using leverage.\n      <\/li>\n      <li>\n        <strong>Yield curves could flatten or invert.<\/strong> A Fed that showed\n        true commitment to price stability would send a powerful signal that it\n        prioritizes bond investors, and that could lead to a meaningful drop in\n        long-term bond yields.\n      <\/li>\n      <li>\n        <strong>Dollar could rally, hurting exports.<\/strong> U.S. currency\n        would also tend to appreciate as higher rates and the central bank\u2019s\n        commitment to preserving the dollar\u2019s purchasing power would make it a\n        desirable holding.\n      <\/li>\n    <\/ul>\n    <p>\n      Looking over the list of likely impacts raises the question if the Fed can\n      bear the consequences of a \u201cwhatever it takes\u201d mindset to price stability.\n      To begin with, a policy that prioritizes bond investors hurts bond\n      issuers, and the U.S. government is the biggest issuer of them all. By\n      preserving purchasing power, the Fed would make it more costly in real\n      terms for the federal government to repay its debt even if nominal\n      interest rates came down.\n    <\/p>\n    <p>\n      A falling equity market, a strained federal budget, and slower economic\n      growth could also engineer a U.S. recession, something that we think looks\n      remote in the current economic data. No Fed chair or central bank wants to\n      take a strong economy and lead it into a downturn.\n    <\/p>\n    <!-- SECTION -->\n    <h2>Discretion is the better part of valour<\/h2>\n    <p>\n      Given the institutional incentives, we think it will be tempting for Fed\n      officials to err on the side of caution and move slowly. It\u2019s easy to find\n      a justification: monetary policy acts with a lag; rapidly rising rates\n      could create financial system stress; lower-income households would bear\n      the brunt of rising credit charges\u2014the list goes on. Talking tough but\n      failing to deliver eventually leads to a reckoning. And after half a\n      decade of above-target inflation, it may be time for the policy the Fed\n      should implement to become the policy it will implement.\n    <\/p>\n","protected":false},"excerpt":{"rendered":"<p>The question for investors is always what the Fed will do, not what it should do. Recent economic data has opened the potential for an abnormally large breach between the two frameworks. We look at the possible effects for investors and the economy.<\/p>\n","protected":false},"author":22,"featured_media":35934,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"_jetpack_newsletter_access":"","_jetpack_dont_email_post_to_subs":false,"_jetpack_newsletter_tier_id":0,"_jetpack_memberships_contains_paywalled_content":false,"rbcwm_post_date":"2026-11-12T10:58:10","editor_notices":[],"rbc_url_alias":"","rbcwm_featured_desktop_image_position":"","rbcwm_featured_mobile_image_position":"","_jetpack_hide_featured_image":false,"_jetpack_featured_image_duplicate_dismissed":0,"_jetpack_feature_clip_id":0,"_jetpack_memberships_contains_paid_content":false,"footnotes":"","jetpack_post_was_ever_published":false},"categories":[73],"tags":[1084,1193,1194,1047],"rbcwm_content_owner":[607],"rbcwm_need":[],"rbcwm_segment":[],"rbcwm_solution":[],"rbcwm_topic":[74],"rbcwm_channel":[],"rbcwm_format":[],"class_list":["post-35933","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-analysis","tag-federal-reserve-2","tag-interest-rates-2","tag-u-s-central-bank","tag-u-s-economy-2","rbcwm_content_owner-pag","rbcwm_topic-global-insights"],"acf":{"rbcwm_subtitle":"The question for investors is always what the Fed will do, not what it should do. Recent economic data has opened the potential for an abnormally large breach between the two frameworks. We look at the possible effects for investors and the economy.","rbcwm_post_author":"","rbcwm_custom_breadcrumb_text":"","rbcwm_custom_breadcrumb_link_url":"","rbcwm_disclaimers":{"add_disclosures":["Yes"],"perspective_disclaimer":"","expandable":"","omit_from_pages":"","disclaimer_footnote":""},"rbcwm_insight_cta_id":[11937],"rbcwm_pagination":{"next_link":"","next_link_text":"Next article","previous_link":"","previous_link_text":"Previous article"},"rbcwm_video_duration":"","article_time":"","rbcwm_enable_toc":false,"rbcwm_toc_selector":"h2","rbcwm_toc_sub_selector":false},"yoast_head":"<!-- This site is optimized with the Yoast SEO Premium plugin v27.5 (Yoast SEO v28.4) - https:\/\/yoast.com\/product\/yoast-seo-premium-wordpress\/ -->\n<title>The space between Federal Reserve theory and practice<\/title>\n<meta name=\"description\" content=\"The question for investors is always what the Fed will do, not what it should do. 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